Do stricter home loans mean more mortgages in arrears?

Australia’s banks have been recently taking steps to lend money more responsibly, making it that little bit harder for some Aussies to get a home loan. However, according to the Reserve Bank of Australia (RBA), this tightening of lending standards may be partially responsible for a recent increase in the number of Australians falling into arrears on their mortgage repayments.

In a speech to the 2019 Property Leaders’ Summit, Jonathan Kearns, the head of the RBA’s financial stability department, broke down the reasons why Australia’s rate of housing loan arrears has grown to the highest level in many years (though still well below the levels seen in the 1990s recession).

Some of the factors affecting arrears were found to include borrower income, unemployment and housing prices. For example, parts of Western Australia affected by the end of the mining boom were found to have arrears rates around double the rates seen in the rest of the country. The increased arrears in the rest of the nation could be partially attributed to house prices having fallen 8 per cent from their peak; auction clearance rates and volumes having declined; and properties taking longer to sell; all making it more difficult for borrowers to escape arrears by selling their property.

The other factor Mr Kearns found to be affecting arrears rates was home lending standards, e.g. how difficult it is for borrowers to take out larger, riskier home loans. Recent pressure from regulatory bodies such as the Australian Prudential Regulation Authority (APRA) and the Australian Securities and Investments Commission (ASIC) has led many banks to enforce tighter lending standards, such as offering fewer interest-only loans or loans with high Loan to Value Ratios (LVRs), as well as increasing scrutiny of borrowers’ income and expenses.

According to Mr Kearns, tightening lending standards may temporarily increase arrears rates. For example, limiting interest-only lending means that some borrowers with existing interest-only loans may be unable to roll over their interest-only periods, and may struggle to afford their new principal-and-interest mortgage payments. Plus, tighter lending standards can make it harder for borrowers to refinance home loans, which can lead to arrears if their income or financial circumstances change and they can no longer afford their current loan.

But while tighter lending standards may contribute to higher home loan arrears in the shorter term, they are expected to gradually lower Australia’s rate of home loan arrears over the longer term, as higher-standard loans are more likely to be resilient to the effects of future economic downturn.

According to Mr Kearns, while Australia’s arrears rate may continue to rise for a bit longer, low unemployment and strong lending standards should help keep rates of arrears from rising high enough to affect Australia’s financial system. Mr Kearns also pointed out that while Australia’s rate of arrears is now around the level seen in 2010, it’s still relatively low on an international scale, with around 1% of Australian loans in arrears compared to more than 4% in Spain.

“Indeed, another way to look at the arrears rate in Australia is to note that over 99 per cent of housing loans are on, or ahead of, schedule. Making loans involves risk, and banks are used to managing this risk. If the arrears rate was persistently very low, that would suggest that lenders were being too cautious in lending. In that world, some people who could almost certainly repay a loan would struggle to get one.”

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